CHAPTER 8 VALUING & FINANCING AN INTERNET START-UP Explore cash flow, price-earning ratio (P/E), price-earning growth (PEG),& business model based methods in valuing start-up/new company. Financing strategies, different source of financing “You need money to make money”
WHEN TO CASH OUT (WITHDRAW MONEY) DURING FIRM’S LIFE CYCLE : revenue received during business period, can use cash inflow to cover any expenses or cash outflow COLLECTING EARLY: selling equity to gain early profits, the buyer gets a piece of the company usually venture capital, individual investor (rich people), or go through INTIAL PUBLIC OFFERIC (IPO)list your company to MESDAQ the Bursa Saham Malaysia , anyone can buy share & you make money Investment bank that has lots of money & interested in your company
E.G. IPO RICH-RICH COMPANY SDN BHD (SOFTWARE DEVELOPER)
Paid up capital RM 50,000
Revenue year 1 RM 40,000
Contract 5 years ,RM 5million
Needs capital, What to do?
RICH-RICH COMPANY BHD (SOFTWARE DEVELOPER) OR IPO BANK LOAN
Get big fast
Equity shared by people
Public know what's your
Long term liability
Can keep own company
VALUATION OF A BUSINESS CASH FLOW PRICE-EARNING (P/E) PRICE-EARNINGS GROWTH (PEG)
1. CASH FLOW Value of a stock, bond or business is determine by the cash inflows & outflows Advantage of internet companies over traditional business is that Internet properties used & improved cash flow Amazon. COM +ve cash flow, holds no inventory thus, –ve operating expenses FREE CASH FLOW-cash from business operation available for distribution to its claim holder, equity investors & debtors-that provide capital.
2. PRICE-EARNING (P/E) RATIO Reflects investor’s expectation of future earnings Compare with same industry Example pg 147. I’m rich. COM 2001 Year 2002 earnings $3million Year 2003 process of going public -suggest that issue $5 million shares during IPO Other P/E ratio of same industry firm are 80. What should your share price be? P $0.6 P E 80 $48 = = => P =
Shortcoming of P/E ratio Firm can be profitable but have –ve free cash flow There are more than 1 type of earnings, to decide which one to use is not easy Because you are comparing, therefore whether historical earnings are a good predictor of future earnings are questionable.
3. PRICE-EARNINGS GROWTH (PEG) RATIO Analyze the role of growth Same formula as P/E ration with adjustment to growth P/E Growth Rate Stock with PEG ratio less than 1.00 are good buys Has limitations/shortcomings Valuable information lost =
VALUATION OF BUSINESS THAT ARE NOT YET PROFITABLE How do you estimate the value of a firm that has –ve earnings? Use this method: Firm & industry Proxies Business Model Approach: Earnings & cash Flow Chain Implications of Market Value for Financing & Investment Strategies
1. Firm & Business Proxies A firm’s share price is estimated using the P/E ratios of analogs Analyzing a firm based on its industry growth, target market & leader in its category
2. Business Model Approach: Earnings & cash Flow Chain Turn a firm’s business model for some indications of future earnings potential Technology & internet firm tend to loose money in their early years of operation & gradually gain market & money along the way Its indicator of future profitability are profit margin, market share, revenue growth. Figure 8.2 method used in estimating share price
3. Implications of Market Value for Financing & Investment Strategies How can one tell is a firm is over valued? Compare P/E ratio of current firm to historical P/E ratios of firm in same industry Check pg 150 example.
INTELLECTUAL CAPITAL: VALUING THE PARTS Intellectual capital: Unpriced physical assets /intangible assets, patent trade secrets Human capital-people that turn assets into products & services Product market position Unique resource or capabilities knowledge
Components of Intellectual capital Intellectual property Human capital-workers Organizational capital-customer value & cultivate more intellectual property
1. Internal Sources: Assets & Activity Firm can use retained earnings Retained earnings = profit that firm makes, net any dividends that paid to shareholders Firm can use existing assets for innovation Hewlett Packard & Apple starts in garages in Silicon Valley
2. Equity Firm can also issue equity thro’ equity financing-giving equity as share to investors, in return giving the firm capital/management Issued through IPO-popular in 1990’s Venture equity -VC/Venture Capital comes in & finance firm in early stage of company formation by asking for share in the company & sits on its board & gives management advice-seek cash after company becomes IPO, e.g. NETSCAPE,AMAZON.COM e.c.t. Drawbacks of this method- the VC had control over you- usually 51% of the company
3. Debt Borrow money to finance your company Needs collateral- something to put in before money can be given-banks, financial institution, along Interest payment, major setbacks for star-up companies. Working capital financing- used by AMAZON.COM-smart form of debt financing Malaysian banks.
4. Complementary Assets Paired assets by strategic alliances with partners team up with other firm that has assets